New study: Net­works play a key role in CEO pay and wage in­equal­ity with­in com­pan­ies

The market for CEOs is a bit like the market for football players: it is hard to determine the true value of the best. If you want the top candidate, you need to offer more than your competitors and then you bid up each other until only one buyer remains.

But pay can still vary widely between CEOs – even in companies of the same size and industry. New research from CBS points to networks as an often overlooked explanation for this phenomenon.

“We wanted to explore why some CEOs earn significantly more than others, even when they lead companies of the same size in the same sector,” says Thomas Poulsen, Associate Professor at the Department of Accounting at CBS and author of a new article on CEO pay published in the scientific journal Socio-Economic Review.

Together with Lasse Folke Henriksen, Associate Professor at the Department of Organization at CBS, and Dustin Avent-Holt, Professor at Augusta University, USA, he has analysed 20 years of executive pay data from all Danish companies with more than 250 employees.

The study shows that only the top 25 percent and especially the top 1 percent of CEOs have seen substantial increases in real wages. For the remaining 75 percent, pay has been more or less flat for nearly two decades.

The debate on high executive pay is therefore really about a very small part of the business elite, Thomas Poulsen stresses.

The stronger the network, the higher the pay

The study is part of CBS’ Business in Society initiative, which aims to shed light on different forms of inequality. It was here that Thomas Poulsen and Lasse Folke Henriksen discovered a shared interest in how pay is shaped and distributed within and across companies.

Their collaboration launched a deeper exploration of the social and structural mechanisms behind top-level pay in Danish business.

At the heart of their research is the CEO’s and board’s position in the Danish business network: Who knows who, and how central is their role in overlapping board positions across companies.

“The more central the CEO’s position is, the greater the pay premium they are able to negotiate,” explains Thomas Poulsen.

The researchers also looked into what this means for the rest of the workforce. They found that in years where a CEO secures an extraordinary pay premium, employees tend to experience slower real wage growth compared to workers in other companies.

 “The CEO takes a larger slice of the cake – and the cake does not necessarily grow,” says Thomas Poulsen, pointing to the potential downsides of this trend:

“Economic inequality undermines social cohesion, trust in institutions and social mobility. Moreover, it fuels political polarisation.”

At the same time, he acknowledges that there is another side to the story:

“A CEO who performs well should reasonably be rewarded for their efforts as long as it does not come at the expense of others who have also contributed to the company’s success. That can only happen if the cake grows,” says Thomas Poulsen.

A strong board can counterbalance executive power

There is, however, one effective counterweight to powerful executives: a strong and well-connected board, Thomas Poulsen explains:

“The stronger the board’s own network is, the smaller the pay premium a powerful CEO is able to negotiate.”

In fact, when a board is sufficiently strong, the CEO’s ability to negotiate any premium at all disappears entirely.

According to the researcher, board fees pale in comparison to the highest CEO salaries, so it can be a worthwhile investment for a company to ensure a well-connected board. And beyond the financial aspect, there are many other benefits to having a central board. That said, it can be easier said than done.

“You cannot just decide to have a more central board,” Poulsen points out.

It takes time to understand the company you are joining as a board member, and centrally positioned board members often have packed schedules because of their many board roles. Some of them are also CEOs themselves and do not have the capacity to take on more responsibilities. In addition, companies on the periphery of the Danish business community may find it harder to attract board members from the core.

New trends in the Danish labour market

The effect of networks on CEO pay premiums points to a broader deregulatory trend in the Danish labour market, according to Thomas Poulsen. He notes that collective agreements have lost influence over the past decades, while pay has increasingly become a matter of individual negotiation in many workplaces.

“As pay formation becomes more individualised, it becomes easier for the CEO to demand more for themselves and cut back on employee pay,” says Thomas Poulsen.

Despite these developments, Denmark still has a highly regulated labour market, with high union participation and a large share of collectively agreed wages.

“When these trends are already visible in Denmark’s relatively regulated model, they are likely to be even stronger in more deregulated markets,” Thomas Poulsen notes.

The fact that you can identify such a clear link between networks and executive pay in a labour market as regulated and egalitarian as Denmark’s suggests an even stronger effect in less regulated markets.

“Our results speak to labour and leadership models beyond Denmark,” concludes Thomas Poulsen.

Whether boards should ultimately pay full price for the ideal CEO candidate remains a decision for each individual company.  However, he does recommend that boards keep an eye on how their pay policies evolve – especially if they accept unusually high salary demands from their CEO.

If you want to know more, you can read the full research article here

Contact:

Researcher, Thomas Poulsen: tpo.ccg@cbs.dk
Communications Consultant, Anders Nørland: an.slk@cbs.dk